Jumbo vs. Conforming Residential Loans
In many of today’s real estate markets, home prices have increased to a point where conventional conforming loan size limitations just don’t do the trick. This is where jumbo loans come into play. Many similarities exist between conforming and jumbo loan products. There are also some distinct differences and even some benefits jumbo loans can offer over and above conforming loan programs. Both types of lending are considered “conventional” in lending lingo.
Let’s explore a comparison of the two.
Fannie Mae & Freddie Mac
Home lending in the U.S. used to reflect on how the jumbo residential market continues to function today. This happened because lenders, prior to the Great Depression, used to lend to borrowers seeking to acquire a residence by reaching into their institution’s own deposits. This is still largely the same process for today’s HELOC (home equity lines of credit), land, construction lending, and for the jumbo loans that we’re discussing.
Fannie Mae and Freddie Mac are today’s clearing houses for conventional lending. They’re a direct result of the housing fallout from the Great Depression. Fannie Mae was created in 1938 to kick-start the availability of liquidity back into residential markets across the country. However, Fannie Mae didn’t go public until 1968. Freddie Mac was chartered in 1970 for the same purpose and to act as a balance to Fannie Mae. This balance is crucial in preventing Fannie Mae from becoming a monopoly.
Both offer liquidity to financial institutions looking to lend on residential mortgages so when they’re made, they can be sold off through Fannie Mae and Freddie Mac. Other lenders, home loan servicers, and loan aggregators can also acquire these loans directly knowing that they meet Fannie Mae’s and Freddie Mac’s standards.
What About Government Lending Products?
To round out the home lending picture, FHA, VA and USDA* are all labeled as “Government” lending products. They are similar to Fannie Mae and Freddie Mac for both the underwriting and trading process. However, a major difference is government loan programs have forms of government backing in the case of unpredictable defaults down the road, which protects the lenders who are originating these loans.
Today’s jumbo lending looks a lot like yesterday’s pre-Fannie Mae lending with the notable exception that decisions are no longer made by a “loan committee” once a week in some dark room of a local bank. There are also all of today’s tools available to the jumbo lending process, meaning that jumbo borrowers and homes are validated using today’s technology.
The Obvious Difference: Loan Sizes
Conforming loans through Fannie Mae and Freddie Mac have loan size limitations. These limitations are revised annually and currently have a single-unit national maximum at $484,350. Additionally, some areas of the country are deemed “high cost”, allowing those markets to have conforming loan limits of $726,525. 2-4 units have further escalating conforming loan limitations. For example, a four-unit property in a high-cost marketplace will cap out at $1,397,400 for conforming financing.
Alternatively, jumbo loans are not subject to a national maximum. They have individual lender maximums that are not standardized across all lenders. This is because those institutions lending out on jumbo loans are actually lending money from their assets. Take that in for a second. Jumbo lending is, in essence, still from a bank’s vault. Home lending is often described as lenders lending “someone else’s” money. For large jumbo loans, this is not the case. Understandably, and because more money is being lent against a single property vs. many, there’s a greater concentration of risk inherent in each jumbo transaction.
Mitigating the Concentration of Risk
So, what does this added layer of risk mean to home loan applicants looking for financing using a jumbo loan? The answer shouldn’t surprise anyone. There’s a little more scrutiny placed upon the quality of the property, the applicant’s credit rating, income and liquidity (amount of actual money or equivalents left over after closing on the home loan), as well as the amount of skin in the game by the homeowners.
This generally means down payments are in the 20% range, or more, for most loan amounts. Sometimes the 10% range is acceptable for smaller jumbo loans; smaller being relative in this category. Borrowers will find that each lender establishes their own underwriting guidelines, which can also change over time. There are no national standards for jumbo home loan underwriting. However, there are common practices with varying specifics for each lender out there.
Credit Score Minimums
Jumbo lenders generally like to see minimum credit scores of 700 or higher. Some lenders start at a minimum score of 740. These numbers are substantially higher than minimum credit scores for conforming and government loan products.
Consumers borrowing jumbo financing need to show that they have access to a higher level of funds in the event of a rainy day. While this makes sense, in combination with the greater down-payment or equity position required of the consumer, these home loans are generally for those who have already proven a history of successful homeownership. In no way does this mean a first-time homebuyer can’t purchase a higher priced home utilizing jumbo financing. They absolutely can if they can also meet the higher requirements associated with the larger down payment and the higher funds in reserve. These higher requirements are reasonable, given that if there is a financial strain down the road there might not be a quick exit from a home with jumbo financing, especially if there are fewer potential homebuyers in the market.
No Secondary Market
There are very nominal amounts of jumbo home loans that will be sold from one institution to another. This has been the case since the Great Recession a little over a decade ago. About 15 years ago, many Wall Street level firms were trading jumbo loans as if they were more commonplace conforming loans. Ultimately, that didn’t work out so well. “Securitizers” didn’t properly underwrite the risk of jumbo lending in combination with other major missteps involving higher risk home loans.
Something You Might Not Expect
Surprisingly, given no secondary market for them, there are times when a jumbo loan’s pricing is very attractive. Sometimes jumbo home loan rates are lower than their conforming counterparts. Although counter-intuitive, jumbo loans can be subject to a different behind-the-scenes cost structure which can make them more competitive than one might think.
Jumbo loans don’t have a Fannie Mae or Freddie Mac guarantee fee which can translate to as much as an eighth of a percentage in interest rate. This translates to roughly 50 basis points or one half of one percent of a loan amount, that doesn’t have to be backed into a jumbo loan’s pricing. Even though this might seem like a small percentage, the result is a lot of money.
Time vs. Process
Lenders also typically price jumbo loans with less overall margin than conforming loans because, while there is a greater risk when larger loans are being made to a single transaction, there is not necessarily more actual work done on these loans. In real-world terms, a $200,000 loan can be just as time-consuming to process and underwrite as a $2,000,000 loan, which is 10x in proportionate size. Those involved in making the loan available won’t put forth an additional 10x in effort in this example.
Jumbo loans are great for those who are looking to buy their dream home or who live in a high-cost region of the country. As a full-service lender, we have experience with jumbo home loans.